Question

Discuss how the uses of estimates, cost, alternative accounting methods, the presence of atypical data, and diversification of firms have been cited can be the limitation of financial statement analysis. Identify financial ratios and explain how one or more of the limiting factors can affect the usefulness of that ratio with reference to literature.

Answer 1

Financial statement analysis is a great tool for evaluating the profitability of a company, but it does have its limitations due to the use of estimates for things like depreciation, different accounting methods, the cost basis that excluded inflation, unusual data, a company's diversification, and useful information

Everything you need to know about the limitations of financial accounting. Financial Accounting is the father of accounting system.

Cost Accounting is a branch of accounting and has been developed due to the limitations of financial accounting.

Financial Accounting gives general information about the major functions of the business such as finance, administration, production and distribution.

Financial accounting aims at presenting a true and fair view of the overall results of transactions and events which are recorded in the books of accounts in terms of money, and in accordance with established principles, accounting standards and legal requirements.

The financial statements, comprising the income statement, position statement as well as the funds flow statement reveal the overall performance and position of the business entity.

Some of the limitations of financial accounting:-

1. Historical in Nature 2. Shows Only Overall Performance 3. No Objective Classification 4. Distinction between Direct and Indirect Expenses 5. Fails to Analyse Material Losses

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6. Labour Cost Control 7. Idle Facilities 8. No Cost Comparison 9. Distortion of Trading Results 10. Only Monetary Information 11. Fixation of Product Price 12. Inventory Levels cannot be Fixed 13. Lack of Data for Decision-Making.

Limitations of Financial Accounting

Limitations of Financial Accounting – Provides Only Historical Data, Static in Nature, Fails to Control Cost, Fails to Analyse Losses and a Few Others

Financial Accounting is mainly concerned with recording business transactions in the books of accounts for the purpose of presenting final accounts to the Board of Directors, shareholders and tax authorities etc. The objective of Financial Accounting is to present a true and fair view of the company’s income, financial position and funds at regular intervals.

In the modern business world, business concerns need some methods and ways by which they can -measure their performance. Financial Accounting cannot serve this purpose at all. The indications given by Profit and Loss Account and Balance Sheet are generally inadequate.

It is just like thermometer which only indicates the temperature of human body. Only judgments can be made on the basis of such thermometer and a good doctor will have to conduct a number of other checks in order to see what the patient is suffering from.

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The profit shown by Profit and Loss Account should not be taken as a sign of success because there may be a loss on certain items which might have been compensated by the profit of certain other items. Information regarding wastages and losses is very difficult to be obtained from financial accounts and it is only Cost Accounts which makes such information available to the management. So cost accounting has emerged mainly because of certain limitations of financial accounting.

i) It shows only Overall Performance – Financial Accounting provides information about profit, loss, cost etc., of the collective activities of the business as a whole. It does not provide data for each and every product, process, department or operation separately.

ii) It provides only Historical Data – Financial Accounting is historical in nature and it provides data of past activities. It does not provide current data which management requires for making effective plans for future. So it is rightly said that financial accounts provide only a post-mortem analysis of past activities. It does not help in fixation of selling price.

iii) It is Static in Nature – Modern business is dynamic and not static. Financial Accounts does not incorporate the changes that take place within the business.

iv) It fails to provide information for Price Fixation – In Financial Accounting; costs are not available by division, products, process etc. So, price fixation becomes difficult and estimates cannot be prepared.

v) It fails to Control Cost – Financial Accounts fail to exercise control over materials, labour and other expenses incurred in a business enterprise. As a result, avoidable wastages and losses remain as it is under this system.

vi) No proper Classification of Costs – In Financial Accounting, expenses are not classified into direct and indirect, fixed and variable and controllable and uncontrollable. These classifications have utility of their own.

vii) It does not provide proper System for Performance Appraisal – In Financial Accounting there is no system of developing norms and standards to appraise the efficiency in the use of materials, labour and other costs by comparing the actual performance with what should have been accomplished during a given period of time.

viii) It fails to Analyse Losses – Financial Accounting does not fully analyse the losses due to idle time, idle plant capacities, inefficient labour, sub-standard materials etc.

ix) It does not provide a Basis of Cost Comparison – Financial Accounting does not provide cost data regarding operations of the enterprise for the purpose of comparing such data with other periods of operations or other concerns in the industry.

x) It fails to provide Adequate Information for Reports – It does not provide adequate information for reports to outside agencies like banks, government, insurance companies and trade associations.

xi) It fails to provide adequate Data to Management – Financial Accounting fails to supply useful data to management for taking various decisions like replacement of labour by machines, introduction of new products, make or buy decisions, selection of the most profitable product mix etc.

xii) Possibility of Manipulation of Financial Accounts – Very often Financial Accounts are manipulated at the whim and fancies of the management so as to project a better image in the minds of prospective investors. Financial Accounts may be manipulated by making under or overvaluation of machinery, excessive or inadequate provisions for depreciation, creation of secret reserves etc.

xiii) It does not make use of Control Techniques – Financial Accounts fail to make use of certain important cost control techniques, such as – Budgetary Control, Standard Costing, and so on. Thus, financial accounts do not facilitate in measuring the efficiency of the business with the help of control techniques.

xiv) It fails to ascertain Break-Even Point – Financial Accounting does not help in ascertaining the break-even point i.e., the sale or output where the revenue equals the cost. Hence, the point of no profit-no loss cannot be found out under financial accounts.

Limitations of Financial Accounting – 9 Major Limitations

Financial Accounting is the father of accounting system. Cost Accounting is a branch of accounting and has been developed due to the limitations of financial accounting. Financial Accounting gives general information about the major functions of the business such as finance, administration, production and distribution.

Whereas Cost Accounting provides the specific and detailed information of the above and the operating efficiency of the various individuals, sections, departments and divisions in an organization. It is very difficult for the management to lay down policies effectively without cost accounting system. Even in the modern era of computer system, Cost Accounting plays the key role in data feeding and processing the business transactions.

The following limitations causes for the development of cost accounting:

(1) Financial accounts disclose the overall profit of the concern but it does not disclose the profit or loss of each department, process or product etc.

(2) Labour or wages are not recorded department wise or product wise.

(3) Expenses are not classified as direct or indirect, controllable or uncontrollable, fixed or variable etc.

(4) No proper procedure to determine the standard or efficiency of an organisation in the use of materials or other resources.

(5) It does not provide the information of losses due to idle time, idle plant and tools, defective materials and the difference between normal and abnormal losses.

(6) Cost information is not available and therefore it is not a guide in determining the price of the product or services

(7) It does not provide any information to the management about the price to be quoted for the future supply of goods and services or predetermined price.

(8) It does not guide the management for proper planning, control and decision-making.

(9) There is no system of computing day to day cost and it provides information only at the end of accounting period.

Limitations of Financial Accounting – Historical in Nature, Overall Performance, No Object Classification, Material Losses, Labour Cost Control, Idle Facilities and a Few Others

Financial accounting aims at presenting a true and fair view of the overall results of transactions and events which are recorded in the books of accounts in terms of money, and in accordance with established principles, accounting standards and legal requirements. The financial statements, comprising the income statement, position statement as well as the funds flow statement reveal the overall performance and position of the business entity.

Such reporting is based on a post mortem examination of past events. Although management has some interest in the information contained in these statements, the information is of little practical significance from the point of view of planning, control and decision-making.

It is, in this context, that Blocker and Weltmer say that “In spite of new accounting devices, improved techniques and elaborate subsidiary records, financial accounting is so limited and inadequate in regard to the information which can be supplied to management that, during the past thirty years, businessmen have been eager to adopt supplementary accounting methods known as cost accounting.”

Cost accounting was thus evolved to overcome the limitations of financial accounting.

In spite of its popularity, financial accounting suffers from the following limitations:

Limitation # 1. Historical in Nature:

Financial accounting is essentially historical in nature. It records transactions and events which have already occurred. As such, the financial statements prepared and presented at the end of the accounting period, report on past events as a part of stewardship function of management. Although, the information is historically important, it does not provide the management with day-to-day information for evaluating operational efficiency.

Limitation # 2. Overall Performance:

Financial accounting discloses and reports profitability or otherwise of the business as a whole. Since it does not classify accounts on the basis of departments or segments, products, processes and sales territories, it fails to provide information about costs and profit of these sub-divisions of the organisation.

Limitation # 3. No Objective Classification:

In financial accounting, accounts are classified under two major groups, viz., and personal and impersonal. Such a primary classification made subjectively, is of little use to management to ascertain costs by products, jobs and processes.

Limitation # 4. Distinction between Direct and Indirect Expenses:

In the case of financial accounting, expenses are not classified into direct and indirect, fixed and variable, controllable and uncontrollable, and assigned to departments, jobs or products. As such, controllable items of expenses cannot be distinguished from uncontrollable ones for purposes of cost control and cost reduction.

Limitation # 5. Material Losses:

There being no material control system operating under financial accounting, there is no safeguard against material losses consequent upon wastage, pilferage, deterioration and obsolescence of materials.

Limitation # 6. Labour Cost Control:

In the case of financial accounting, there is no means of comparing the time clocked with the time booked since workers are paid on the basis of hours worked. Consequently, losses resulting from idle time, evasion of work and loitering cannot be controlled. Further, labour time is not recorded job-wise. Hence, there is no means of judging the efficient utilisation of labour time and no incentive systems based upon results can be introduced.

Limitation # 7. Idle Facilities:

Financial accounting does not reveal losses due to idle plant and equipment. Such losses can neither be analysed nor controlled.

Limitation # 8. No Cost Comparison:

Financial accounting does not provide data for comparison of costs of two periods, two firms, two jobs, departments or processes. As such, it is not possible to arrive at conclusions regarding the profitability or otherwise of different products, jobs, departments, processes or sales territories.

Limitation # 9. Distortion of Trading Results:

In financial accounting, the values of closing inventories is estimated for the purpose of income statement and balance sheet. If the values are not stated accurately, matching of costs with revenues cannot be done properly. Consequently, trading results become distorted to the extent of variation in values.

Limitation # 10. Only Monetary Information:

Financial accounting records contain information relating to transactions and events of a business entity capable of being expressed in terms of money. There is no place in these records for non­monetary information such as quantity of materials and quality of labour, etc.

Limitation # 11. Fixation of Product Price:

Financial accounting records do not furnish the required information regarding quantity and costs to enable management to fix the price of products, jobs and processes or services rendered. Financial accounting also fails to explain the reason why there is rise or fall in cost of production.

Limitation # 12. Inventory Levels cannot be Fixed:

Financial accounting fails to supply the necessary information to management for fixation of stock levels such as maximum level, minimum level, ordering level, etc. In the absence of fixation of such levels, investment in inventories cannot be optimised.

Limitation # 13. Lack of Data for Decision-Making:

Decision-making is one of the basic functions of management of any organisation. However, financial accounting fails to furnish the required data for such decisions as introduction of a product- line, discontinuance of production of a product or a department, whether to make or buy, equipment replacement, suitable product-mix, etc.

Limitations of Financial Accounting

Financial accounting provides a post-mortem examination of past events and, hence, not amenable for exercising control measures. It does not offer a running commentary on the profitability of various jobs, departments or processes in an organisation. These serious limitations have ultimately paved the way for the emergence of cost accounting.

Let us examine the limitations of financial accounting in greater detail:

i. Financial accounting discloses only the net result of the collective activities of the business as a whole. It does not indicate the profit or loss of each division, department, job, process or contract.

ii. Expenditure is not split according to departments, processes and products and, hence, prices of articles manufactured cannot be accurately fixed.

iii. Financial accounting fails to indicate the remunerative prices which may be quoted in times of depression.

iv. It does not ensure proper control over materials and supplies, wages, labour and overheads.

v. Expenses are not classified as direct and indirect items and are not assigned to the product at each stage of production to show the controllable and uncontrollable portions of overhead costs.

vi. It does not provide any measured to judge the efficiency of the concern.

vii. It is historical in nature, since data is summarized at the end of an accounting period. Prompt cost information on a daily basis is not available.

viii. It does not provide a complete analysis of losses arising out of idle time, idle plant and equipment.

ix. It does not offer useful cost data for comparison with previous periods.

Is Trading Account a Locked Storehouse of Invaluable Information?

The list of limitations as far as financial accounting is concerned, is painfully long. Over the years, the number of people criticizing financial statements is also increasing. Against this background, it’s not easy to find scholars taking a positive view of the whole thing. Let’s look into what.

W.Hawkins L has stated in this regard – “the ordinary trading account is a locked storehouse of most valuable information to which costing is the key”. To elaborate, the trading and profit and loss account present a summarized view of the working of an enterprise during a specified period and the costing system, with its objective and analytical approach, discloses the detailed information relating to profit or loss.

Cost accounting tries to look into those areas which are either neglected or ignored in financial accounting and tries to present results in a more meaningful manner— facilitating managerial planning and control.

Limitations of Financial Accounting – 12 Deficiencies of Financial Accounting that Led to the Development of Cost Accounting

The following deficiencies of financial accounting are the causes for the development of cost accounting:

1. Financial accounting discloses only the net results of the overall activities of business; but it does not reveal the profits of each department, process, products, jobs, etc.

2. Materials and supplies are not properly controlled; as such deterioration, misappro­priation, obsolescence, losses from scrap, defectives etc. are the consequences.

3. Labour charges and wages are not recorded by jobs, departments, or services; and as such no interpretation is possible in the light of costing systems.

4. Expenses are not classified as to the direct and indirect items; and they are not assigned to each job to controllable and uncontrollable items in overhead costs.

5. There is no well-developed system of standards to measure the efficiency of the organ­isation in the use of materials and other resources.

6. Financial accounting is a historical data, summarised at the end of the accounting period; and as such no up-to-date cost information is available to the management to make effective plan for the succeeding year.

7. It is not a guide in determining the prices of products, services, jobs etc. because cost information is not available.

8. It does not give complete information of losses due to idle time, idle plant and equip­ment, defective materials; moreover, such losses are not distinguished into normal and abnormal wastes or losses.

9. Cost reduction is not possible to maximise profits, as the financial accounting does not disclose factors responsible to rise or fall in the cost of production.

10. As it does not give data, no comparison can be made either of two periods or of two firms.

11. Detailed or adequate information is not available from financial records for reports to outside agencies—banks, credit associations, governments and for the purpose of comparison with other periods or firms.

12. It does not guide the management for proper planning, control and decision-making, as the financial accounting is maintained only to find out the trading results during a period.

Limitations of Financial Accounting – Provides Information as a Whole, Historical in Nature, No Objective Classifications of Costs, No Appraisal of Efficiency and a Few Others

Financial accounting may be defined as – “the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are in part at least, of a financial character and interpreting the results thereof”. Financial accounting provides financial information to the managers of the business and also to outside parties such as- shareholders, customers, employees, income tax and sales tax departments and general public.

Such information is expressed in the following two financial statements which are prepared at the end of financial year:

1. Profit and Loss Account – It shows the net profit or loss during the period. This is also known as Income Statement.

2. Balance Sheet – This statement shows the financial position of the business i.e., assets and liabilities as on a particular date. This is also known as Position Statement.

Financial accounting is so limited and inadequate in regard to the information which it can provide to management that businessmen have been eager to adopt supplementary accounting methods like cost accounting.

The following limitations of financial accounting have led to the emergence of cost accounting:

i. Provides information about the business as a whole – Financial accounting provides information about profit, loss, cost etc., of the collective activities of the business as a whole. It does not give data regarding costs by departments, products, processes and sales territories etc.

ii. Historical in nature – Financial accounting is historical since the data are summarised only at the end of the accounting period. There is no system of computing day-to-day cost and also computing pre-determined costs.

iii. No Objective classifications of costs – In financial accounting, expenses are not classified into direct and indirect, fixed and variable and controllable and uncontrollable. These classifications have utility of their own.

iv. No information for fixation of prices – Financial accounting does not provide cost data for fixation of prices of products. This makes it difficult for a company to quote prices of its products and submit estimates.

v. No system to control material cost – Generally there is no proper system of control of materials which may results in losses in the form of obsolescence, deterioration, excessive scrap and misappropriation etc.

vi. No control over labour cost – Financial accounting does not provide for any system to control labour cost. Labour cost is not recorded by jobs, processes or departments and as such no system of incentives may be easily used to compensate workers for their above standard performance.

vii. No appraisal of efficiency – In financial accounting, there is no system of developing norms and standards to appraise the efficiency in the use of materials, labour and other costs by comparing the actual performance with what should have been accomplished during a given period of time.

viii. No control over idle facilities – Financial accounting does not provide any system to check losses due to idle plant capacities, idle time of labour, etc.

ix. Fails to supply relevant data for decision making by management. Financial accounting fails to supply useful data to management for taking various decisions like replacement of labour by machines, introduction of new products, selection of the most profitable product mix, etc.

x. No scope for Cost Comparison – Financial accounting does not provide data for the purpose of comparison with other similar firms to improve its efficiency.

Limitations of Financial Accounting – Historical Data, Improper Classification of Expenses, Price Fixation is Difficult, No System to Control Material Cost and a Few Others

Financial accounting is so limited and inadequate with regard to the information which it can provide to the management, that businessmen have been eager to adopt supplementary accounting methods like cost accounting.

The following limitations of financial accounting have led to the emergence of cost accounting:

1. Historical data- Financial accounting contains historical cost information accumulated at the end of the accounting period. The historical cost is not a reliable basis for predicting future earnings, solvency or overall managerial effectiveness.

2. Improper classification of expenses- In financial accounting, Expenses are not classified into direct and indirect, fixed and variable, controllable and uncontrollable. These classifications have utilities of their own.

3. Looks at the jungle, rather than the trees- It discloses only the net result of the overall activities of the business but it does not reveal the profit of each department, process, product, job, etc.

4. Price fixation is difficult- It does not provide cost data for fixation of prices of products. This makes it difficult for a company to quote prices of its products and submit estimates.

5. Cost comparisons are not easy- It does not provide data for comparison of costs of different periods, different departments, products or jobs.

6. No system to control material cost- Usually, there is no proper system of control of materials which may result in losses in the form of obsolescence, deterioration, excessive scrap and misappropriation, etc.

7. No control over labour cost- It does not provide for any system to control labour cost. Labour cost is not recorded by jobs, processes or departments and as such, no system of incentive may be easily used to compensate workers for their above-standard performance.

8. No scope for performance appraisal- In financial accounting, proper norms for efficient use of material, labour and costs are missing. As a result, there is no way to find out whether everything is progressing as planned or not.

9. Fails to supply relevant data to the management- It does not provide necessary information to the management to take important decisions about expansion of business, dropping of a product line, etc.

10. Not amenable for introduction of modern techniques- It does not offer any room for the introduction of sophisticated techniques that are essential for cost ascertainment and cost control.

Limitations of Financial Accounting – No Provision for Material Control, Classification of Accounts in a General Manner, No Records for Wastage and a Few Others

Financial accounting, which is historical in nature, is mainly concerned with the recording of day-to-day business transactions. It is simply a post-mortem of the past events. Under financial accounting, business transactions are first recorded in the books of original entry, then classified into ledger and finally summarised by preparing Trial Balance.

From trial balance, the Profit and Loss Account or Income Statement is prepared to ascertain the periodic profit or loss and Balance Sheet or Position Statement is prepared to ascertain the financial position of the business as at the end of the accounting period.

Financial accounting gives only a general idea about the working of the business and permits the management to control, in a general way, the major functions of the business viz., finance, production, administration and distribution. But it does not give details regarding the operating efficiency of these divisions.

Financial accounting suffers from the following limitations or deficiencies:

Limitation # 1. No Provision for Material Control:

Financial accounts do not contain detailed particulars of materials consumed in a manufacturing concern. Although, the financial accounts record the value of opening and closing stocks and the cost of raw materials purchased, they are silent as to the quantity of the various items of raw material issued to different departments or jobs and the price at which they have been issued. Therefore, the cost of raw material consumed for the manufacture of a particular unit of output cannot be ascertained from financial accounts.

Limitation # 2. Non-Availability of Detailed Particulars about Labour Cost:

Financial accounts contain the record of the total wages paid to the workers during a specified period but they are silent as to number of workers employed, number of workers engaged on different jobs or in different departments, number of hours worked by each worker, rate of wages, total wages paid job-wise, product-wise or department-wise etc.

Financial accounts also do not contain separate records for direct and indirect wages. Further, no distinction is made between the wages of efficient and inefficient workers. As such it becomes difficult to ascertain as to whether the increase in the wage rates of workers or increase in the number of workers has led to a corresponding increase in the quantity of output or not.

Limitation # 3. Classification of Accounts in a General Manner:

Under financial accounting system, accounts to be prepared are classified into personal, real and nominal accounts. Such a classification of accounts does not help in ascertaining the cost of production product-wise, job-wise, department-wise, work-order-wise etc.

Limitation # 4. No Classification of Costs into Direct and Indirect Items:

In financial accounts prepared under the financial accounting system, costs are not classified as to direct and indirect items and are not assigned or allocated to each product at each stage of production or to each department or process.

Limitation # 5. Ascertainment of True Cost of Production not Possible:

Financial accounts keep a record of all the expenses of the business whether or not these are relevant to cost of production. As such, the exact or true cost of a product, job, work-order or process cannot be ascertained from financial accounts nor can we decide as to whether or not all the relevant items of cost have been considered in ascertaining the total cost.

Limitation # 6. No Provision for a System of Standards:

In a manufacturing concern carrying on production on large scale basis, its manager generally finds himself unable to supervise personally each and every activity involved in the manufacturing of goods. As such standards and targets have to be fixed in advance for various activities of the manufacturing concern.

The actual performance is to be compared with the pre-determined standards in order to find out the differences and to provide for their analysis and remedial action, in case the performance is below standard. Financial accounting system has no provision for such a system of standards.

Limitation # 7. No Records for Wastages:

Under financial accounting system, no records are kept in respect of the wastage of materials, man-hours and machine- hours taking place during the course of production. As such, no steps can be taken to eliminate or to minimise the various types of wastages.

Limitation # 8. No Assistance in Fixation of Selling Price and Calculation of Tender Price:

Financial accounting system fails to supply data regarding the true or exact cost of production on account of which the manufacturer finds himself unable to fix a competitive selling price for his products. Many a times, a manufacturer or a contractor has to submit quotations or tender to a prospective customer for the supply of a large quantity of a product at some future date or for the execution of a contract.

The quotation price or the tender price should be competitive. A competitive quotation price or tender price can be determined with reference to the past cost data and changes anticipated over the previous cost levels. Since financial accounting system does not supply data relating to true cost of production, the preparation of tenders and quotations becomes a difficult job.

Limitation # 9. No Assistance in Cost Control:

Financial accounting system does not help the management in controlling costs since it does not provide for a system of cost control.

This limitation arises on account of the following reasons:

(i) In financial accounts costs and expenses are recorded only after these have been actually incurred or spent. Hence, financial accounts do not leave any room for taking corrective action.

(ii) Financial accounts do not have any technique to check the reasonableness of any cost or expenditure.

(iii) Financial accounts do not help in fixing the responsibility on any individual for any wastage or excessive cost.

Limitation # 10. Financial Accounts Deal only with the Over-all Profitability of the Business Concern:

Financial accounts of a business concern are so designed as to disclose the overall profit or loss of that business concern for a specified period. Financial accounts do not deal with the product- wise, job-wise, process-wise, department-wise profitability of the business. Hence, the unprofitable activities of the business are not disclosed and the necessary steps cannot be taken to make them profitable or to discontinue them.

Limitation # 11. No Provision for Comparison of Costs:

Financial accounts do not provide data for the comparison of the costing results of a particular period with that of other periods of operation of the same business concern or with that of other concerns in the same line of industry.

Limitation # 12. No Assistance in Planning and Decision-Making:

Financial accounting system does not provide any guidance and assistance to the management in taking various important decisions relating to the operations of an undertaking.

The management may require information for the following purposes:

(i) Evaluation of the profitability of the alternative methods of production

(ii) Selection of the most profitable product-mix or sales-mix

(iii) Manufacture or buy decision

(iv) Operate or shut-down decision

(v) Determination of sales required to earn desired profits

(vi) Ascertainment of the effect of changes in selling price on profits

(vii) Determination of the Break-even Point, Margin of Safety etc.

Financial accounting system does not provide the required data and assistance for the purpose of making decisions on the above mentioned matters.

All these limitations of financial accounting system have led to the development of cost accounting system.

Limitations of Financial Accounting – 5 Important Limitations

It is essential to understand the various limitations of financial accounting.

1. Financial accounting provides the results and financial position of the business, but does not provide reasons for change in results.

2. It provides results of the past period and hence offers a post-mortem analysis of the performance of the enterprise, which might not facilitate any corrective action.

3. It provides only the overall performance of the business and does not offer any information about performance of each product, division, department, individual, etc., thereby hindering any related decision and corrective measures.

4. Financial accounting is not helpful in managerial decisions like-

(a) Pricing of a product

(b) Making or buying a component

(c) Adding a new product to the existing product line

(d) Discontinuing an existing product or line

(e) Profitable product mix

(f) Choice of marketing channels

5. Financial accounting does not provide any basis for future estimations and planning.

These limitations can be overcome by systematically accounting for costs apart from other financial transactions. Such system of accounting for costs and enabling effective decision making is known as cost accounting.

Limitations of Financial Accounting – 11 Major Limitations

The function of financial accounting is concerned with that of bookkeeping, i.e., maintenance of records of costs, debtors and creditors etc. In course of time, it has become necessary to maintain the records in order to comply with legal requirements, such as taxation, labour legislation, company legislation, etc.

As per the company law requirements, company has to maintain the accounts for their adoption by the shareholders in Annual General Meeting. Thus, financial accounting requires set of accounts for statutory and proprietary purposes. The stress is on the ascertainment and exhibition of profits earned or loss incurred without due regard in respect of planning, control and decision-making.

The branch of cost accounting began to grow as a separate subject in the early 20th century because of the various limitations of the Financial Accounting which are discussed below:

1. Financial Accounting is mainly concerned with the preparation of Profit and Loss Account and Balance Sheet at the year-end in a summarised form useful to the owners, investors, creditors and Government. In some cases, periodical accounts are also prepared. But, Cost Accounting aims at continuous reporting of cost data.

2. Financial Accounts will not reveal the data by jobs, processes, products etc.

3. It provides the historical data only and it would be too late for any corrective action.

4. It does not provide data for adequate control over materials, labour and overheads.

5. In financial accounting, there is no system of setting of predetermined estimates, standards or budgets.

6. It provides information in terms of expenses, income, assets and liabilities but the expenses are not divided into direct and indirect, or fixed, variable and semi-variable.

7. It does not provide adequate information about the losses or inefficiencies occurring in any form such as waste—whether of materials, time, expenses or in the use of machinery, equipment and tools.

8. Changes in business conditions or plans of expansion or contraction of activity cannot be handled properly in financial accounts.

9. It fails to guide properly in framing pricing policy.

10. The data is not sufficient for managerial decisions.

11. It does not include the imputed costs.__